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UK chaos infecting markets as pound extends its record loss

The big question for pound traders may have been answered, but the outlook for the currency is murkier than ever.

PHOTO: SPH

[LONDON] The big question for pound traders may have been answered, but the outlook for the currency is murkier than ever.

Sterling dropped 3 per cent to $1.3275 at 11.05 am in London on Monday, after reaching a three-decade low of $1.3222 that surpassed its weakest level reached in the immediate aftermath of the vote to leave the European Union.

The extra losses added to the unprecedented 8.1 per cent tumble on that day, which was almost double the 4.1 per cent decline on Black Wednesday in 1992, when the UK was forced out of Europe's exchange-rate mechanism.

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Gains in UK government bonds pushed the 10-year gilt yield below 1 per cent for the first time on Monday, the FTSE 100Index of stocks slid 1.2 per cent, and Barclays Plc and Royal Bank of Scotland Group Plc fell more than 10 per cent.

"People are finding it difficult to comprehend what Brexit implies for the future - we don't know yet what the magnitude of the shock will be," said Steven Barrow, head of Group-of-10 strategy at Standard Bank Group Ltd in London.

"So far, in terms of sterling-dollar, we've seen half the decline we're likely to see this year."

The pound weakened against all the world's currencies after Britain voted to leave the European Union, pushing it to the lowest level since 1985 versus the greenback.

The turmoil extended into Monday even after Chancellor of the Exchequer George Osborne sought to calm markets, saying contingency plans were in place to shore up the economy amid ongoing volatility.

Investors face months of uncertainty - the mechanics and terms of the UK's exit are yet to be determined, and the nation's political leadership during the negotiations is unclear after Prime Minister David Cameron announced his resignation.

The opposition Labour Party has been thrown into chaos, Scotland is agitating for independence and in Belfast, republicans Sinn Fein called for a referendum on Irish unification.

'More Concerning'

"We've seen so many developments around Brexit over the weekend since the FTSE closed and things are now looking even more concerning," Angus Nicholson, Melbourne-based analyst at IG Ltd, said by phone.

"It's hard to have any idea about where fair value for the pound should be when you look at the fact that Scotland and Northern Ireland could no longer be part of the UK within the next year or two."

The chance of a Brexit has dominated pound trading in 2016, and sterling was the most visible casualty as the UK's decision to quit the EU rippled through global markets on Friday.

While a weaker currency may boost domestic exporters, it could increase prices for consumers and complicate the Bank of England's efforts to meet its inflation remit. And it may also ramp up pressure on politicians to speed up decisions on what steps to take next.

"From here, a 10 per cent fall relative to the US dollar seems about right," Kit Juckes, a London-based strategist at Societe Generale SA, said in a Bloomberg Television interview on Sunday.

"The low point will be somewhere between $1.20 and $1.25. However much you want to say the UK will survive and calm down, the uncertainty is going to have an economic impact, and the uncertainty is magnified at the beginning by the politics."

Unprecedented Event

Britain and the rest of Europe are now feeling their way through the unprecedented situation, with an early sticking point being the timing of the exit negotiations themselves. Mr Cameron, who will address Parliament on Monday, said Friday that the UK will wait until a new prime minister is in place before triggering the Brexit process by invoking Article 50 of the Lisbon Treaty. European leaders have called for talks to begin immediately.

While pro-"Leave" politicians sought to minimize the financial turmoil seen on Friday, recent European history has shown how politics can start driving markets, only for the relationship to swiftly reverse.

During the euro region's debt crisis at the start of this decade, investors played the role of vigilantes by dumping sovereign bonds and pushing governments to act.

"There's a lot of questions that need to be answered right now - the longer this takes the more the pressure is going to be on the pound," Vasileios Gkionakis, head of currency strategy at UniCredit SpA in London, said in a Bloomberg Television interview on Sunday.

"The reaction we saw in the market on Friday was largely the result of speculative activity. What we haven't really seen is the flow, the reversal of flows coming out of the UK When these start unwinding I'm pretty sure that we're going to see some enormous pressure on the pound." A drop below $1.20 is possible, according to Mr Gkionakis.

Recent price moves are in line with what economists predicted would happen following a Brexit decision. In a Bloomberg poll earlier this month, most participants saw the pound plunging below $1.35 the day after a vote to quit the EU.

BOE Governor BOE Governor Mark Carney sought to restore confidence on Friday by saying that officials will take any steps needed to secure stability. Even that may not be positive for the pound, with investors having boosted bets on an interest-rate cut since the referendum, a move which would likely weaken sterling further. Futures suggest a 50 per cent chance of a rate reduction next month, up from 11 per cent on Thursday.

"The UK's natural inclination over the past century has been to let the pound take the strain during times of crisis," said Simon Derrick, chief currency strategist at Bank of New York Mellon Corp. in London.

"Given events over the weekend, that probably means more pound weakness at the start of this week. To me, that's a sign that UK markets are working efficiently and doing what they're supposed to do."